the euro mess

Standard & Poor yesterday downgraded Greece’s sovereign credit rating to the lowest in the world – close to a default rating. A second rescue package for Greece (€172 bn) has been delayed because of a dispute between Germany and the European Central Bank (ECB). The German government wants to force current holders of Greek bonds to swap them for new, longer-maturing bonds. The ECB insists that compulsion would amount to a de facto default, so wants any debt rollover to be voluntary.

NYU economist Nouriel Roubini thinks that the dispute over restructuring is beside the point. Debt restructuring is necessary and inevitable but, in itself, will not restore Greek competitiveness and growth. “Here the options are limited”, he writes.

The euro could fall sharply in value …, to restore competitiveness to the periphery; but a sharp fall of the euro is unlikely given the trade strength of Germany and the hawkish policies of the European Central Bank.

The German route — reforms to increase productivity growth and keep a lid on wage growth — will not work either. In the short run such reforms actually tend to reduce growth ….

Deflation is a third option, but this is also associated with persistent recession. ….

[T]here is really only one other way to restore competitiveness and growth on the periphery: leave the euro, go back to national currencies and achieve a massive nominal and real depreciation. After all, in all those emerging market financial crises that restored growth a move to flexible exchange rates was necessary and unavoidable on top of official liquidity, austerity and reform and, in some cases, debt restructuring and reduction.

Nouriel Roubini, “The eurozone heads for break up“, The A-List, 13 June 2011 (FT registration or subscription required).

Debt restructuring, Roubini concedes, will make the exit option less attractive. Without restructuring, “the option of exiting the monetary union will become dominant”.

Nouriel Roubini (born 1959) is co-author of Crisis Economics: A Crash Course in the Future of Finance (Penguin, 2010), which was recently released in paperback.

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